America is changing. Read some chillling words from a liberal economist

The crash of the post-WWII debt supercycle will ripple out though our society in ways we cannot now imagine. There are a few who can grasp the trend of events and see what lies ahead.

Like this article by Brad Delong, economics professor at Berkeley: “Today in Financial History“, posted at his blog Grasping Reality with both hands, 29 September 2008. I strongly recommend reading this. It gives a valuable if somewhat long and technical analysis of our situation. More important are his conclusions, of special significance because the Obama administration will hire either DeLong or others like him. So his analysis is academic speculation, but not just academic speculation.

He concludes with some chilling words.

Five more notes:

First, last spring Larry Summers had good arguments that we had then set in motion enough policy moves to resolve the crisis and save the world economy from depression. We had implicitly guaranteed the unsecured debt of every large investment bank in the United States. And we had greatly strengthened the implicit guarantee of Fannie and Freddie. That should have been enough. But clearly it wasn’t.

Second, I don’t believe that after this the price of risk will ever again become a free-market price, just as after the Great Depression the short-term price of liquidity–the short term interest rate–ever became a free-market price. The federal government, in one form or another, is going to be in the business of insuring debt securities against steep declines in value. Securities that are not so insured will simply not be traded. What Fannie Mae did for “conforming” home loans, the Treasury or some other government agency will do for derivative securities. It will offer insurance, charge for that insurance, and supervise and oversee financiers much more strictly.

Third, the market fundamentalists in other sectors will need to be quiet for quite a while. We have just seen financial markets rife with moral hazard, agency, and adverse selection problems crash spectacularly. Is this a situation in which we should move health care–also rife with moral hazard, agency, and adverse selection problems–toward a free market configuration? No. Market regulation needs to be smart. But first market regulation needs to be.

Fourth, there is now no time for tolerance of the three objections to this analysis and this plan of action, roughly:

it’s immoral,

it’s unfair, and

it can’t work in the long run.

To expand a bit:

It’s immoral because people have a right to be treated like adults–which means that they have a right not to be rescued by the government from the consequences of their bad judgment, and we are violating that right.

I dismiss objection (1). It is made, mostly, by those who speak for the Princes of Wall Street. … The response to objection (1) is that the people who make it need to grow up. There is no more a John Galt or a Jane Galt than there is a Santa Clause. There are no Randites in a financial crisis–or no even quarter-sane Randites. The fact that there is a safety net in a financial crisis is something that has been obvious to everything with a spinal column for at least a century and a half–that’s what central banks are for, for Jeebus’ssake! The Princes of Wall Street did not earn their fortunes by virtue of their virtue, their intelligence, their nerve, their skill, and their willingness to run great risks, et cetera, et cetera, low animal cunning, glue, money sticks as it blows by.

The response to objection (2) is “tough.” Yes, it is important to design the elements of the rescue package in such a way as to give as few windfalls as possible to the undeserving feckless, greedy, imprudent, thriftless, et cetera. We will do what we can within the law to make sure as few gains ill-gotten survive going forward. But as Federal Reserve vice chair Don Kohn says, it is bad public policy to hold the jobs of tens of millions hostage in an attempt to teach a few feckless financiers (or even somewhat more thriftless borrowers) even a much-deserved lesson.

The response to objection (3) is that it was first made by Karl Marx at the end of the 1840s: that the problem is not overspeculation but rather overproduction, and cannot for long be solved by paliatives that address overspeculation only:

… Fifth, later on we should talk more about the corollary to the refutation of objection (1)–the fact that there has always been a safety net for the rich makes it an obvious matter of simple justice that there be a safety net for the poor and the middle class as well. But for the present the important thing is to make sure that people who argue for tax cuts for the rich or for welfare-state program cutbacks for the poor should not be allowed to disrupt the formulation of public policy when there is serious public business to be done.

Analysis

This is a manefesto for the greatest expansion of government power since the New Deal, and a large large step away from a free-market system. If the government controls the price of money (the short-term riskless rate of interest) and the price of risk (through government control of markets), then America will have changed. Among the keys to our success are rapid growth, dynamism, and high rate of social mobility. Delong will trade all these away for security and stability. We will be like France.

That is not the apocalypse. But it is a big change.

Note the slick but bizarre rebuttal to objections. If you don’t agree to this expansion of government power, then you are a Marxist! As if there were no reasonable objections.

Delong is unusual in that, perhaps in the heat of the recent market “crash”, he explicitly stated his objectives. The people who will make these changes to our system are unlikely to be so forthright. It will occur with a thousand reforms, each plausible and small, none threatening.

Background

Like many in America’s left — and right — wings, Delong shows strong authoritarian tendencies. Esp. note the intolerance for political beliefs that differ from his own, which he often considers illegitimate — in the sense of being outside the realm of reasonable or even proper political positions. For example:

(b) His frequent diatribes against any deviation by the mainstream press from leftist orthodoxy, which he headlines as “Why can’t we have a better press corps?” This is absurd given the well-documented liberal bias of the mainstream media. See this, this, this (there are dozens more) — as any pro-Republican articles are signs of dis-functionality, but pro-Democratic Party articles are ignored as right and proper).

Don’t bother posting opposing views in the comments on his site. However well-documented or mildly expressed, they are usually deleted. Must not disturb the faithful by revealing to them that there are reasonable opposing views.

This crisis has long been forecast by many, including in articles on this site. Even now that we are in the whirlwind, these provide valuable background material on its causes — and speculation about the results. To see the all posts on this subject, go to the FM reference page about The End of the Post-WWII Geopolitical Regime. Here are some of those posts.

17 thoughts on “America is changing. Read some chillling words from a liberal economist”

Fabius, while I have admired much of what I have read on your blog, I must say that I disagree with some assertions you are making in this particular post. I feel I should state them.

1. You say, His frequent diatribes against any deviation by the mainstream press from leftist orthodoxy. But Delong is not a “leftist”. He’s a liberal. This guy is a leftist. This guy was a liberal. As you can see it is not the same thing at all, and the difference has to do with their attitude toward capitalism.

2. There is no ‘liberal bias’ in the press corps. Since they are run by corporate entities which wish to curry favor with the state in exchange for freindly legislation, they are biased toward favoring whatever regime is currently in power in Washington. This state of affairs also makes them biased toward favoring pro-business policies. In practice, this means that they are in fact usually pro-conservative.

3. Finally, Delong’s plan may be a bad one, but still you have to admit he’s spot-on in his assessment of randian thought. The USA has never really had a ‘free market’ system, and never will. Such a destructive system would never be allowed to exist! Rather, the USA has always had a pro-corporate form of state-controlled capitalism.
.
.Fabius Maximus replies: By the numbers…

(1) You say po·ta·to, I say whatever.

(2) The liberal bias of the mainstream media has been demonstrated over decades by studies using a wide range of methods. Using LEXIS to analyse word use (e.g., Methods of identifying people: many “right wing” peope, few “left-wing”). Examing records of party membership and campaign contributions. Surveys of how reporters self-identify their political beliefs. Studies of job history (many worked in Democratic campaigns or for Democratic officials, few for Republicans). To just deny this is a bit much.

(3) No political or economic regime exists in pure form. The US had one system until the New Deal, and another afterwards — neither a pure free-market system. I know of nobody who believes otherwise, so Delong’s insight about this is not noteworthy. To see a pure free-market system one must first die (probably in Hell, as we’re told Heaven is an absolute and perpetual monarchy).

I don’t think it matters who runs and who advises the next administration. The economic problem is beyond the scope of any single nation’s fixing. America will have its recession, jobs will be lost, businesses will fail, credit will be tight (because no one trusts what’s on another bank’s balance sheets anymore), more bailout funds will be demanded and given, the rest of the world will follow us into the same recession, and it will be several years before we start to recover.

But what is this fear of the end of “free market” capitalism? Unregulated capital (credit default swaps, deregulation of debt to equity requirements for the major banks,e.g.) are what got us into this mess in the first place. Everyone admits this now. Free markets, like alcohol, may be good in moderation, but are not a panacea.
.
.Fabius Maximus replies: In the real world nothing is a panacea, and nobody of sense says otherwise IMO. (Extreme Libertarians are not people of sense, IMO)

We just experienced the consequences of a massive failure of the government’s regulatory apparatus (finance, esp banking, is perhaps our most highly regulated economic sector). Blaming “free market” action for this, and advocating more government regulation, seems like a “hair of the dog that bit me” remedy. I suspect it will not be successful.

Chilling is an understatment. I find that there seems to be a strain of micro-management that is not only infecting our political class but our citizens as well. It’s not going to be pretty.

“Sometimes it is said that man cannot be trusted with the government of himself. Can he, then be trusted with the government of others? Or have we found angels in the form of kings to govern him? Let history answer this question.”
— Thomas Jefferson

I guess the people think they have found angels to save them. They can really only save themselves.

FM, I expect more from you in this type of situation than l-word name calling. The conservative, laissez-faire capitalist approach has now twice produced major, gigantic crashes for the middle and lower class while the upper class did well. This is objectively true and must be dealt with neither by royalism or peasants with pitchforks and torches.

It is indeed the prospect of the latter that gave birth to our upward-mobility, greed-based society… it was conceived as a way to forestall things like more Napoleons, and Marxism. To a great extent the New Deal was an effort to prevent a violent revolution. Does anyone think that given how armed and divided this country was before this financial meltdown, that there is not a threshold that will lead to 4GW right here?

It is also quite ironic to quote Jefferson in this context… in addition to what he said quoted above, he also stated that there should be one violent revolution per generation, and smoked weed and has mixed-raced descendants. I suppose if he were alive today he’d be a right-wing televangelist? Or perhaps an ardent Obama supporter? Pick one.

The core problem, it says here, is that we have processes, the Constitution and the Congress specifically, that use 18th century paradigms in the 21st. Now some of these are indeed valid, because they are based in human nature. But others are based in the social and technological realities of that time and are obsolete. When the Constitution was written and approved, money and information traveled at the speed of horses and sailing ships. One could win a major battle (New Orleans) in a war that was already over. Nowadays these phenomena move at the speed of electrons, and freely across borders. We need solutions, not name-calling. Got any of the latter?
.
.Fabius Maximus replies: Good point about Jefferson. He was in many ways a radical then, as in your cite about revolutions (he loved the French Revolution). As for the rest…

“than l-word name calling.”

I try to always provide quotes when responding, since so many responses to my posts (like this, with no direct reference) I find incomprehensible. To what does this refer?

“The conservative, laissez-faire capitalist approach”

This problem has been building since WWII, thru periods government by different parties, Administrations with different political views. The post-1982 period in which debt growth accellerated say 4 Administrations:
* Reagan and Bush II (for which your description fits),
* Bush I (conserative, but a big-govt & pro-regulatory version)
* Clinton (neither conservative nor laissez-faire).

The economic and regulatory regime changed little under these presidents (and equally large swings in Congress) because it was bi-partisian. As I note in #2 above, finance is our most highly regulated sector. This crisis results from a failure of that regulatory apparatus. To call that system “laissez-faire capitalism” is just bizarre. If the regulatory system was twice and large and intrusive — then failed — would you say the same thing?

“It is indeed the prospect of the latter that gave birth to our upward-mobility, greed-based society”

I suspect you will find it difficult to support this statement. I doubt our society resulted from anything so deliberate or planned. Specifically, finding anything in the New Deal that encouraged “upward mobiltiy” or a “greed-based society.”

“The core problem, it says here, is that we have processes, the Constitution and the Congress specifically, that use 18th century paradigms in the 21st.”

This paragraph just goes over my head; I have no idea to what you are referring.

“To Brad: Second time thru this and it’s still good analysis but not certainly leading to the (pre-desired) conclusion blaming the market. Why not have the Treasury fund a new program where the gov’t owns more housing — and offer to buy 1 million units at an avg price of $200k (50% of prior mortgage offered — a floor of maximum loss). $200 bln.”

From Delong’s excerpt quoted in this post:

“Third, the market fundamentalists in other sectors will need to be quiet for quite a while. We have just seen financial markets rife with moral hazard, agency, and adverse selection problems crash spectacularly. Is this a situation in which we should move health care–also rife with moral hazard, agency, and adverse selection problems–toward a free market configuration? No. Market regulation needs to be smart. But first market regulation needs to be.”

This is only true if Fannie Mae, and the 1995 ammended CRA, were part of the Free Market. But they’re not.

Unintended Consequences of BAD BAD BAD gov’t intervention is why the paper-wealth is gone. (And you want the same kind of gov’t intervention in health???)
.
.Fabius Maximus replies: The discussions here run differently than those at many well-known sites. Delong’s aggressively deletes non-leftist comments, no matter how mild and well-supported. RealClimate deletes and even edits comments questioning global warming. The Small War Council bans people expressing heterodox views.

Greg Panfile (11:14am supra) — Could you clarify your comment, “It is indeed the prospect of the latter that gave birth to our upward-mobility, greed-based society.”?

“The latter” seems to mean to “peasants” (Hooverville proles?) who might’ve responded “with pitchforks and torches” to the system that produced the Crash and Great Depression. If so, would “our upward-mobility, greed-based society” be referring to the post-WW2 mixed-market society that had its genesis in the New Deal?

Do you mean to suggest that upward mobility was a novel innovation of FDR’s Brain Trust, unknown to previous generations of Americans? And that greed, too, only made an appearance in the New World in March of 1933?

I might argue to the contrary. Greed was not unknown to the Founders. An alternative to designing a greed-free system for New Soviet Man might be to consider which systems of social organization might operate successfully, despite being run by men and women who from time to time display such human failings. As well as more noble traits.

Fabius, I’m interested in your comments on this interpretation of the economic problematic: “Burning Down The House: What Caused Our Economic Crisis?”
.
.Fabius Maximus replies: I don’t watch vids unless they contain pictures of pretty girls. And if I did watch vids, I would not watch political attack vids. Life is far too short.

The “l” word to which I referred was left… the point being that there are too many dimensions involved for the old dualities to apply.

There is, indeed, historical evidence to indicate that the European elites in the 19th century conceived of our current system as a way to divert peasant attention, to keep as much of the old system in place for as long as possible.

I’d be among the first to admit that there is no programmatic means to eliminate greed, as it is such a basic, human, survival-oriented characteristic. However, I would submit that it, like anger, lust, name your favorite deadly sin, must be constrained if we are to survive, not to mention evolve. Obviously the very greedy cannot be expected to do this voluntarily. Ergo there must be an outside, collective agency with popular support. In other words, the government.

The Congress has and has always had the mandate to regulate interstate commerce. Unless any of the financial entities involved operated in only one state, which is ridiculous, they are all subject to Congressional regulation. The question is not whether or not, but how. Clearly a better job needs to be done. Along with the Presidential candidate I support, I believe that active involvement by all people of intelligence and good will, regardless of party and ideology, will produce the best outcome in this as in almost any imaginable situation.

Labels and mistakes of the past are useful tools for shaping the future… but not if misused in such a way as to terminate discussion with thought-ending cliches. Similarly, when it comes to housing or compensation, there is a ‘point of tolerance’ that, when exceeded, means that ‘free’ market forces deprive citizens of their inalienable rights… at which point, by the just consent of those governed, free markets have to be restrained, as do the physically stronger people, etc.
.
.Fabius Maximus replies: I do not believe the “old dualities” every applied (worked as explanations of US public policy and political dynamcis). They are however a useful shorthand, useful in some circumstances.

Also, in the “background” I explicitly stated that this was not a view unique to the left: “Like many in America’s left — and right — wings, Delong shows strong authoritarian tendencies.”

The rest of your post could have been written in 1930, as support for our existing regulatory structure. So far as I can tell, it provides no explanation as to how our existing — large, almost all-powerful, intrusive — financial sector regulatory mechanism failed. It was not for lack of scope or power, so I suspect increasing its dimensions will have zero beneficial effect, only unanticapiated and unpleasant outcomes. It is the “hair of the dog that bit me” remedy.

Fabius: of course there were few references to “left-wing” people. There is no left-wing in the US. However, if you count the use of the word “liberal”, you will see that the MSM has faithfully echoed the perjorative conservative use of that term.

The financial sector may once have been the most strictly regulated economic sector in the US, but that all changed, starting with Clinton’s Banking Modernization Act, and accelarated in recent years as more and more exotic investment vehicles, like sub-prime mortgages and CDSs flooded the market without any regulation at all.

Yes that was a “failure of the regulatory apparatus”, but only in the sense that we lacked the political will to defend it against the pressures of Wall Street. You are equivocating when you suggest that that proves the failure of the concept of regulation itself.

It must be noted that Investment banks are less regulated than deposit banks. While you may use the words all-powerfull and intrusive to descrive the regulations on Deposit banks , it is not True that the US investment banking regulatory system is intrusive , compared to MOST of the world investment regulatory systems , it is extermley de-regulated except for some formal “stuff”. If the Investment bankers were regulated the same way deposit banks were , you could have claimed that more INTRUSION failed.

Also, it is clear that you favor to maintain the status-quo of finance regulations , But you cant justify this because the US DIDN’T have strict financial regulations especialy towards invetment banking.

the general lack of regulation outside the deposit banking sector is Clear.
.
.Fabius Maximus replies: I am not familar with the regulatory regime of other nations. But US brokers and investment banks are highly regulated, with intrusive and comprehensive powers. Note that the largest (by size) problems were in Bank Holding Companies, not investment banks. The major source of systemic weakness were the most closely regulated of all, the GSE’s.

To say that there is a general lack of regulation of brokerage firms and bank holding companies is absurd. This confuses what they have the ability to do with what they choose to do. Giving them more authority and power will not make them smarter or more capable.

Also, i’m too short of knowledge , experience , methodology , and logic to argue with you on this subject. but a sector where minimun capital is not required , debt/capital ratios as high as 30/1 , assets are no TRULEY adjusted to risk, and no information about the risk , amount and rating of securities is available to regulatory commissions is not a highly regulated sector.
.
.Fabius Maximus replies: You are confusing what the regulators can do with what they choose to do. Giving them more power does not make them more capapble or smarter.

I shudder to think anyone would take Brad DeLong at his word. He’s not a Liberal, he’s a gigantic Marxist and wrong about anything regarding economics in a very frequent basis. How on earth did he get a professorship?

FM, you wrote: “it provides no explanation as to how our existing — large, almost all-powerful, intrusive — financial sector regulatory mechanism failed. It was not for lack of scope or power.” Fair enough, so here is a try at it.

When financial institutions reported on the debt they were carrying, loans, etc. they estimated the value of that debt, and all securities based thereon (mortgage and other based assets, and derivatives thereof including the legendary credit default swaps). The problem was, there was no way to verify that those assets had those values, and no disclosure of the models used to arrive at them. Generally speaking the values were based on unverifiable and flawed assumptions that history predicted risk. In this case, they assumed that repayment patterns would remain stable and that home prices would keep rising. Had they incorporated the possibility, nay the probability, that there would be an economic downturn that would change repayment patterns, and that home prices could or would fall, they would have had to value those assets at a far lower price.

Because derivatives in general, credit fault swaps in particular, are and were completely unregulated, the current crisis happened. Now it may be true that if the Democrats had not tried to work against market forces and put more people in homes despite their economic ability to afford them, the current crisis would not be as bad. But it is also true that Republicans reduced regulation, and resisted new regulation, and controlled Congress for 12 of the last 14 years and had veto power for the last 8, at all times insisting that regulation bad, making all the money you can any way you can, good.

However if the only thing that went wrong was people lower down on the food chain being foreclosed on, that would be a limited problem that could be attacked in various ways. Instead, the ‘masters of the universe’ types, having no actual product to sell, no actual service to perform, made stuff up, and made a lot of money doing it. And they did it in an opaque and unregulated way, and made it permeate the entire financial system. And that is why, as pathetic as it is, some variant on the Paulson plan to clean up that bad paper is necessary.
.
.Fabius Maximus replies: None of this is correct, with respect to the role of the regulators.

The regulators had and have broad discretionary power to regulate both bank holding companies and accountants — the two foci of this crisis. To say the derivative markets were unregulated is correct, but that is by choice of the regulators. The chief US participants were all bank holding companies (e.g., JP Morgan, BankAmerica, Citicorp), all subject to regulatory pressure in a thousand ways.

The use of “tier 2” and “tier 3” pricing (market to model, mark to myth) was again made with the authorization of the regulators, and totally under their control.

in The US you have an almost belief in your superiority, Dynamism is an element of success, but compared to european nations the US had many advantages in terms of natural resources and land. the Success of the US is not astonishing when compared to Japan , which did build-up rapidly with meagre natural resources and where the government ministries had a significant role in terms of planning and setting objectives

my main point is the US advantage lies in the Nation’s geographical characteristics , and not its Dynamism which is shared by many nations developed and non-developed.

So how is the US better than Germany lets say or even France , per capita income is at similar levels , but in Germany and France they have better distribution of wealth.
.
.Fabius Maximus replies: Companing lifestyles, wealth, and income across nations is a difficult task. Wikipedia has some numbers, GDP per capita. Esp comparing small nations like France or Germany to the US. I believe comparing the EU to the US — both similar in population — is more appropriate. Germany or France should be compared to NY or California, the most developed of their economic and social regions. Per the CIA factbook (from Wikipedia), the EU is $34 thousand, France and Germany both $40 thousand, the US $46 thousand.

Note that France and Germany have a more equitable distribution of wealth, but far lower levels of social mobility (from memory, I don’t have any of the studies about this in my files).